Oil States International, Inc. (OIS) Earnings Call Transcript & Summary

Good morning. Welcome back to the JPMorgan Energy Conference. Glad to have you joining us today. Next up, we're going to spend some time with the team from Oil States. We first have Cindy Taylor, CEO; and her CFO, Lloyd Hajdik, will also join in a bit for some Q&A, but we'll start with some prepared comments. So just by way of introduction, Cindy has been CEO of Oil States since May of 2007. She's led the company through a significant number of changes over the years, most recently with the acquisition of GEODynamics in 2018. Lloyd's been with the company since joining as CFO in 2013, and he's held a number of other positions at prior companies, including at Helix and Halliburton. So Cindy, great to see you. Let me turn it over to you, and then I'll come back on in a few minutes.

Hi, Sean, it's great to see you as well, I'll say, albeit virtually. So it's nice to see familiar faces again in the industry. We pulled down our investor presentation that we post to our website, and I thought I would hit just 7 or 8 slides just to bring the audience up current in terms of what we're dealing with as an industry and as a company. And just to lead off, if I could direct your attention to Slide 3, we just want to emphasize our commitment to sustainability. And I would point out that on our website, we have now posted our first inaugural ESG report, and so it's there for all of our investors to access and focus on. And I always say ESG is broad when you cover all the topics that are involved. However, if I were to just focus on current events and tell you where our minds are, I'd have to say first and foremost is our response to the COVID-19 pandemic, both as a company and as an industry and very critical to us is protecting the health and welfare of our workforce, our employees globally. I always say if it were just about getting people to a downtown office to work, this would be already up. But we do have global operations, manufacturing facilities all over the world, and we've got service personnel rotating daily on offshore rigs, land rigs and the like, and so we've been very proactive and also very safe to date. We've had very few instances of either presumed exposure or certainly cases and none of them being severe. And so we're very pleased with that, and it's also equally important that we protect the environment that our customers are working in as well as the communities that we interface with. And so I have to highlight that as one of the key things that we are focused on currently. The second one is, of course, our investors do need demand and identify with profitable operations and long-term returns on invested capital. Needless to say, this economic environment has been challenging with -- particularly with the rapid decline in activity in U.S. shale completion activity, and so we've had to take fairly significant steps to proactively respond to that. I'll cover that in a bit more detail as we progress through the next slide. The other thing that I think we have really focused on through many cycles -- I was looking back in my working history, and this is my sixth, I will call it, major cycle, there have been many, many cycles along the way. But as you do that, I really do believe in the benefits of diversification, and that is both geographic diversification, product line diversification as well. And with that, we have such a long history of manufacturing expertise, research and development that we are really trying to focus on some of the other areas outside of core oil and gas longer term that do include our military exposure, the exposure to industrial activities and more recently, opportunities around offshore wind. Again, we have expertise in offshore installations and developments, and so we are looking to try to carry forward that expertise into other businesses as well. If I could get you to move forward to Slide 4, this is just an overview of Oil States. I will say for many people in the audience, we have an operating history that spans over 75 years. We've been public now for roughly 20 years, and so I think you do know a lot about our business, our business lines. And so I won't go into extreme detail, but we do come to market through 3 business segments. Those are our Offshore/Manufactured Products segment, Well Site Services segment and as Sean mentioned, effective with the first quarter of 2018, our Downhole Technologies segment that we entered into via the acquisition of GEODynamics. The latter 2, being our Well Site Services and our Downhole Technologies are very much exposed to U.S. shale completion activity, which, as everybody on this call knows, has a very significant impact near term from the COVID-19 pandemic and the global response to that. In our Offshore/Manufactured Products business, it's really our shorter-cycle products that are more exposed to U.S. shale activity. And while global activity has softened, certainly not at the rate that U.S. shale activity has. If you look at the lower portion of this slide, it's really more about the relative contribution of each of our segments to both revenues and EBITDA that I would like you to focus on. With our Offshore/Manufactured Products being the largest contributor to Q1 EBITDA at 43%; Well Site Services, 39%, and our Downhole Technologies segment was 18%. That really leads us into Slide 5, which so many people understand what we're going through as an industry and triggered by the global response to the COVID-19 pandemic as well as reduced E&P CapEx as we progress through this fairly extreme cycle. Investors clearly want to know how we are dealing with these challenges. And so we have highlighted a number of bullets on this slide that I'll kind of step you through. But number one, we've always been high technology, tried to be asset-light to the extent that we could be. And to that end, we are able to reduce our CapEx about 70% year-over-year, which will be helpful in terms of stabilizing free cash flow. Direct operating costs will, of course, be reduced as activity declines dictate. We're very focused on that to ensure that we don't have any lagging cost in the system. Probably the harder one for me to think about and address, the needed headcount reductions that have occurred, more weighted to our Well Site Services and our Downhole Technologies segment, again, given that there are very significant exposure to U.S. shale completions. That headcount is down about 40% to 45%. And important to me is that we not just focus on field level cost reductions, we have to look at corporate level, indirect SG&A-type reductions as well and have addressed that with about 20% reductions there. Needless to say, the people that remain have had to share in the pain, as I call it, with salary reductions and benefit reductions or suspensions, at least until we get through the downturn. In connection with our first quarter call, we estimated that we would be able to reduce our 2020 cost by about $225 million. When you compare that to 2019, now a lot of this is going to be cost of sales weighted, i.e., about 87%, which the balance due to SG&A, and we're striving to make 20% to 25% of those costs more permanent in nature, such that when we do recover, we should be able to bring enhanced profitability back to the business. And I'm sure if you listen to the calls yesterday, you heard most of the companies state that Q2 activity fell off faster and harder than most of us predicted it would. When we exited Q1, I would just add to that, that we have also been more aggressive with our cost reduction efforts. And we do predict that we will have incremental cost savings from what we announced in Q1, and we'll give you a full update of that in connection with our second quarter call. If you move on to Slide 6 on the slides, this really gives you highlights of our financial position, and importantly, our debt maturity profile as of the end of the first quarter. We'll go into more details, obviously, in Q&A on that, but I did want to highlight that we put out a news release this morning regarding an amendment with our banks on our credit facility that really accomplishes a couple of things. Number one I would highlight, we really never felt like we have liquidity concerns throughout even this severe downturn. However, as Sean highlighted in many of his notes, as others did, there was a potential covenant breach that would occur to the extent that your EBITDA falls off dramatically and approaches even breakeven results at times. And so we wanted to address that proactively rather than reactively. And while our credit facility does not expire until January 30, 2022, we thought it prudent to get covenants suspension for a period of time, which we achieved, and that suspension goes through March 30, 2021. In return, we reduced our credit facility size from $350 million to $200 million. Again, that reduces exposures for our bank group, but importantly, we really didn't have full access to that amount over the period of time that we have the credit facility in place and nor did we need it. And so I felt like, overall, we've ended up in a good place, and our banks are comfortable with where we ended up as well. If I can take you to Slide 7, one of the key important metrics to look at, particularly in periods like this, is free cash flow generation. And I think one of our greatest attributes is our ability to generate free cash flow through-cycle. And not just in good times, it's got to be through-cycle free cash flow. And if you look at that sub-bullet on the first one, free cash flow positive in 23 of 25 quarters from 2014 through the most recently reported quarter, again, we take great pride in that, and you have to realize there was another significant downturn during this period in 2015 through 2016. The other thing I'd note on this slide is the fact that we had begun repurchasing converts at a discount to market. The average discount for the first quarter that we achieved was a 14% discount. And of course, with the COVID-19 crisis, coupled with movements downward in our stock price, the opportunity to buy back converts at a discount was a bit enhanced through the downturn. If you go to Slide 8, I would focus to my earlier comments. We are global in scope and scale. We have quite a lot of a geographic footprint that helped mitigate some of the near-term downward declines in U.S. shale-driven activity. Leading some of that geographic diversification is our Offshore/Manufactured Products segment that we highlight starting on Slide 10. And I would just focus on the breadth of our offering in very demanding, harsh offshore environments with a variety of equipment offered to the market. The next slide, Slide 11. Again, this is a backlog-driven business, which really helps us with near-term revenue visibility. And the second bullet highlights the fact that our backlog improved about 50% during 2019, gives us a higher base to enter 2020 with. And I guess I'll knock on wood, our book-to-bill ratio for Q1 was right at 1x. We did condition the market. We don't think it will stay at 1x for the full year, but this certainly is a good way to start the year in terms of this particular segment. I did hear comments and questions about the "how intact is your backlog? Do you have cancellations?" And historically, my association with the company now stands 21 years, and we've really never had any significant backlog cancellations nor have we had those to date, so I think we're in good shape there. If I move forward in the slide deck, our Well Site Services, if you look on Slide 16, they are very much tied to U.S. shale completions. However, about 20% of this segment's contribution has come from Gulf of Mexico and international activities, and so those also help kind of mitigate some of the sphere impacts in the U.S. And I'd also like to focus your attention on Slide 18, and that just gives you highlights of the key technologies that we go-to-market with and take to our customer base. The next segment and last one to talk about is our Downhole Technologies segment. Again, we acquired that in the first quarter of 2018 via the GEODynamics acquisition. This particular business is very high technology, has fantastic customer relationships and is asset-light business, well exposed to the demand drivers that are really evident in U.S. shale completions, particularly on the unconventional side. Obviously, this business as well is hit in the downturn with reduced activity in the U.S. I would have you look at Slide 23. A lot of our focus today, the investor base, has been on new product initiatives, research and development, but particularly, our 2 primary integrated gun offerings, named STRATX and vapor gun, again, both of those are now introduced to the market. We're gaining good market acceptance. We actually expanded our perforating revenue in Q1 in a period where the rig count was down. And so we feel good about our positioning, we just need more activity to be able to bring that full technology to bear to the market, also, other products, including our addressable switch. So over the next few quarters, we're very much focused, obviously, on controlling our costs, enhancing our manufacturing capabilities, developing long-term relationships to get these new products to market over time. And I'll conclude my early comments with Slide 25 that just kind of goes through the outlook and where we are as a company, but very important to us right now is the kind of major offshore product, FID, our backlog and our Offshore/Manufactured Products business, again, which gives us some pretty good visibility as we go through 2020. We've seen improvement, obviously, in crude oil prices over time, and we're making pretty significant adjustments. That will lead to a recovery in U.S. shale-directed spending by our customers over time, which will help us begin to see some improvements that we expect as early as the second half of this year. Again, we've got a very long history of generating free cash flow through-cycle. And we continue to focus on research and development, albeit with the caveat that we are prioritizing those investment to projects that we think can generate revenue within the next 12 months. And so you'll see a little bit less invested there, but it will still be a focus. And then lastly, we can talk about it possibly more, but capital allocation will favor debt pay down in the near term. Sean, I'm going to stop there and let us go, make sure we have time for appropriate Q&A.

Great. Thank you, Cindy. Yes. I appreciate the overview. I thought maybe we could just start with the credit facility. You obviously mentioned it, and this is something we discussed on the 1Q call, so we knew that this was on its way. Always trade-offs in these negotiations for both sides, so just like maybe to get your feedback on what you're focused on here beyond just some of the relief itself in the near term, just -- maturity is the same as prior, relief gets you into early next year. I'm just seeing investors will be focused on some of the details here, would be great to hear some of the trade-offs and what you were focused on versus what you're kind of willing to see to get that relief.

Again, we really weren't worried about our liquidity position. We're very experienced going through-cycle, and we know we free up working capital, obviously, in a downturn, and we're doing that currently. It also helps that we were able to carry back our NOLs under the CARES Act, which will give us some added liquidity, I will say, over time. And again, having a good backlog position and the Offshore/Manufactured Products business is just a really nice free cash flow generating business for us that -- it really wasn't about liquidity, but we want a covenant relief over the period of time that we thought we needed it. And again, I felt like it's better to be proactive than reactive. We tied that to working capital, i.e., somewhat of a modified ABL governor. And again, if you look in the appendix, and Sean, you follow us, we've got very strong working capital to cover, not on much coverage of our outstanding borrowings under the revolver, but really, it covers our total debt profile. So I felt comfortable that, that was the appropriate structure for us to go into. Longer term, I think we'll be thinking about a new facility with an extended term that will be ABL-driven. That's just the market, but we do also want it to suit our needs. We're a global company. We've got global receivables, global inventory, and we need to size it appropriately for our business and make sure that we're actually getting credit for the receivables and inventory that we have.

No, very helpful. I appreciate that extra detail. And so then, given -- you mentioned you're a global company, you've got short-cycle and long-cycle exposures. So I think it's a popular topic among investors today, I've asked a number of other executives this week a similar question. Thinking about next cycle and from your perspective, how you think things could be different than what we just -- most recently experienced from a production perspective or production growth perspective? Just thoughts around shale as kind of dominating the incremental barrel versus more restraints on shale producers, potentially leading to more balance in terms of where the barrels come from, some more longer cycle opportunities. Given you play in all these markets, it would be great to hear just your high-level thoughts on how that could unfold and what it means for Oil States.

Definitely. Well, we're going through such a rough patch, and a lot of our E&P customers are very challenged. There's already been announced bankruptcies, and I think there will probably be more. But in any event, however we get there, I think we'll have a more consolidated U.S. customer base, first and foremost. And I do think that when you have that, there will be a little bit less activity driven towards U.S. shale and therefore, lower production. We can all predict whether that takes out 2 million barrels a day, whether it takes up 3 million barrels a day, but I think we all believe that more restrained CapEx, which is demanded by our investors, is going to occur in U.S. shale. And I think for that reason, we're very much going to be focused on the type of technologies that help our E&P customers leverage ultimate returns out of the reservoir. And I think that plays very well into our product offering, both at our Well Site Services segment as well as the Downhole Technologies segment. With that, I've always believed that South America is a very favorable market long term, whether that is Brazil, Guyana, Gulf of Mexico, certainly has its opportunities as well. Middle East, strong, but there are other basins that unequivocally reduce CapEx is going to lead to lower productivity on the supply side, which lends itself to a more favorable operating environment. But it's hard for me to see that U.S. shale necessarily comes back to the level of production that we were looking at previously, certainly not the way to grow in the near term.

Right. Right. Very fair. And so then looking across your businesses, maybe can we get a little bit more detail of where you're seeing the biggest disruptive impacts from COVID. And so just thinking about it, you have manufacturing business, but also you're going to be spending time offshore in international markets trying to provide services, and North America has been quite beneficial and as much as you can get to where you need to be in most cases by truck. So by pick up, that's been helpful. But really, in those international markets, it would be great to get a little more color on where are you're seeing those disruptions and how you see the path back to normality for your business.

Well, I'll certainly comment, but an obvious statement is the most and greatest impact are the indirect impacts, i.e., with the global economic shutdown and the impact on the demand environment has been the greatest. We mentioned on our Q1 call, we had certain manufacturing facilities that were interrupted. Particularly in our Singapore operations, we are back operating and functional. And we've kind of had one-off issues in Brazil or India, but nothing of great consequence. It was more, again, protecting our workers, making sure we had all the protocols in place. There were temporary shutdowns in Singapore. But for the most part, we were viewed as an essential business and were able to work. And so to the extent that we had work in this environment, that progressed fairly well. I would actually say that probably the near term, most immediate things we're dealing with now are more service personnel across the breadth of our operations, trying to qualify and get in foreign locations to do work, particularly the Middle East. I'm sure you've heard from others that a new individual rotating in-country has to sit out for 14 days before they can go out on a job site, and so that lends itself to a lot of nonrevenue days for those personnel, extended pitches, if you will or rotations well beyond what we prefer to do to our employees. And if an offshore rig has a case in -- or any operation, then you kind of go back into another containment strategy, if you will, for the virus. And so inefficiencies, but I think we're dealing with it successfully. And again, I could count on my hands the number of cases that we have and many of which are asymptomatic that have been triggered because someone else in a facility or on a rig has tested positive. And I think that's a lot of what we're dealing with in the state of Texas and possibly the U.S. now is a lot more testing, a lot of that is triggered by presumed exposures and many people are asymptomatic. And if they have symptoms, they're fairly mild. And so we'll knock on wood because I think the most devastating thing that could happen to any of us is if we have a tremendous second wave, massive hospitalizations that lead to a lot more stay-in-place orders globally.

Yes. I appreciate that, and it was very thoughtful. And there's a lot to work through, certainly. So thinking -- let's come back to Downhole Technologies. You mentioned that customer acceptance has been good so far, still very early days and difficult time to be trying to deploy new technology in the market where, just as you said, not a lot of activity. As we come out of this towards the other side, how should we think about incrementals for that business? And just thinking about cost side initiatives, you're already trying to create some efficiency after taking over GEODynamics' facility and expanding the facility, now you're adding new products or maybe some inventory build. So maybe 2 parts: first, how do we think about incrementals on the other side? And then secondarily, how do you think about cash needs for that business as you go to ramp back up from an inventory perspective?

Those are great questions. And I think they're all directed to the Downhole Technologies segment, if I heard you right. But the incrementals proved to be very strong. As you come out of the downturn, they kind of go to your gross margins in your incrementals. And so I think, again, depending upon the individual product, they'll be fairly strong. We are trying to augment that through cost efficiencies, some of which are just forced by the downturn, where we're integrating more of our manufacturing operations, capabilities and skill sets, such that we do believe we're in a great position to start posting very strong incrementals when we come out of the downturn. Again, the issue now is one of cost absorption, and our primary focus is on that. And while we've reduced a tremendous amount of cost in the process, when you have -- shale activity and frac fleets are down as much as 80%, and you can't cut 80%, so I mean, where the downturn, the decrementals are hard, but I do believe the incrementals improve over historical trend lines as we come out of this because of all the actions that we've taken.

That makes a lot of sense. So just -- we've got about just a minute here. I want to maybe just give you a chance to any closing remarks or anything you'd like to just leave with investors about the Oil States story.

Well, I go back to the concluding slide. We have a long history of operations. We've been doing this a long time. I will say, sadly, this is my sixth extreme down cycle, so I don't know that I ever want to get good at it, but we certainly know what to do and how to do it. And I am pleased that, first of all, the -- just the capital markets generally are beginning to open up. The high-yield market is showing some signs there. Quite frankly, the convert market is at record levels. We just don't want to issue converts or renegotiate at our low stock price levels, and we don't think we have to. 2023 seems like decades away right now. And I was just really pleased that despite a very tough bank market, that we had the interest and support of our bank group through this amendment process, and so it does take one less thing to worry about off the table. And we do feel like we're in a sound position despite a really difficult market. I do think we've hit trough levels of activity in Q2. I'm not looking for a V-shaped recovery, but I think we -- every indication from customers is we'll start seeing modest improvement as early as Q3. And so we're managing business on that basis. And again, I look forward to better days and better messages for the broad investor base that has supported us for many years. So thank you, Sean.

Yes. Thanks, Cindy. Thank you, Lloyd. And that's a good way to leave it. All right. Thanks, everyone, for joining.